While there are a number of funds that have consistently failed to beat their sector or benchmark that probably should be avoided, there are others that have fallen into the third or fourth quartile largely because current market conditions don’t suit their style or strategy.
Although backing an underperforming fund may feel like a gamble, they can end up being tomorrow’s winners – starting from a lower base than their peers and often investing in out-of-favour assets.
One recent example is the turnaround in the PFS Downing Active Management fund. SG Wealth Management’s Neil Shillito was lambasted by many readers for recommending the micro-cap fund in 2013, due to its poor track record over previous years.
However, the manager’s different style to the majority of her peers has helped the fund to return 12 per cent in 2014 while the IMA UK Smaller Companies sector has lost money. Eight months is clearly a very short period of time, but Shillito’s reason for holding the fund is because he thinks it will outperform over the long-term, even if it has periods of underperformance.
With this in mind, FE Trustnet asked a selection of industry experts to highlight underperforming funds that they think investors should consider for their portfolios.
Investec UK Special Situations
Alastair Mundy’s £1.2bn Investec UK Special Situations fund has underperformed against the IMA UK All Companies sector and the FTSE All Share this year, but Mike Deverell, investment manager at Equilibrium, says he is sticking by the portfolio.
Performance of fund vs sector and index in 2014
Source: FE Analytics
“It’s currently underperforming, so it is one of those where you think 'should I stick with it or should I sell?' We like it and met with the manager a couple of weeks ago because we were slightly concerned,” Deverell said.
Mundy has told FE Trustnet on a number of occasions that he is concerned about the state of the current market. As a result, he holds 11 per cent of his fund in cash, which has meant he has missed out on various opportunities this year.
However, Deverell says the fund is in his portfolios to defend against over-optimism and to outperform when markets fall.
“His contrarian approach means he will only invest in stocks that are 50 per cent of their peak. He currently holds a lot of cash, which hasn’t helped performance, but that isn’t purely down to a macro call, but because a lot of companies don’t meet his criteria at the moment.”
“This fund doesn’t necessarily need a correction, but if there were to be a sell-off, he would be able to fill his boots and should continue to outperform.”
According to FE Analytics, the fund has been a top quartile performer since Mundy took over in August 2002, with returns of 223.47 per cent. This means it has beaten the FTSE All Share by 44.89 percentage points.
The fund has only underperformed against the sector in three of the last 10 calendar years and was a top quartile performer in the falling markets of 2008 and 2011.
Its ongoing charges figure (OCF) is 0.84 per cent and it has a yield of 2.37 per cent.
CF Odey UK Absolute Return
Another fund that has had a tough time in 2014 is James Hanbury and Jamie Grimston’s £937m CF Odey Absolute Return fund.
While the higher risk portfolio has considerably outperformed its FTSE All Share benchmark since its launch in May 2009, it has struggled year-to-date with losses of more than 7 per cent.
Performance of fund vs sector since May 2009
Source: FE Analytics
Ben Willis, head of research at Whitechurch, says that he expects the portfolio to bounce back.
“One that immediately springs to mind is CF Odey UK Absolute Return,” Willis said.
“We know why it is underperforming and we hold it across a number of portfolios. It is very much like a UK equity fund, though it sits in the IMA Targeted Absolute Return sector. It has had a phenomenal run of late, but the reverse has been true this year.”
Willis says the long/short equity fund has underperformed this year because a number of the managers’ high-conviction stock bets have struggled in this year’s rotation out of high multiple-growth stocks.
However, because of the managers' capabilities, Willis expects their high conviction approach to work out over the longer term.
“We knew this would happen as it is quite directional and we have enjoyed the good times. The managers are high conviction and we would expect them to get through this trough and start outperforming again.”
The fund's OCF is 0.93 per cent.
Geiger Counter Trust
Richard Scott, manager of the PFS Hawksmoor Distribution and Vanbrugh funds, holds the niche Geiger Counter Trust, which invests in Uranium-related companies.
As the graph below shows, the £19.8m trust had performed very well in the years after the financial crisis, but has lost more than 60 per cent over the past three years and more than 10 per cent over one year.
Performance of trust since June 2008
Source: FE Analytics
However, Scott says there are a number of reasons why sentiment towards the trust can pick up substantially from here.
“There is evidence now that sentiment towards resources companies has now bottomed. This has been led by the big majors as changes in management and a focus on cash flow have meant investors have felt more comfortable,” Scott said.
“Geiger Counter only invests in uranium plays, but I think there is scope for a recovery. The risk-reward from this level is very good as the trust had been trading at 140p and is now around 30p.”
Scott says that the Japanese authorities’ decision to shut down their nuclear power plants after 2011's tsunami caused the price of uranium to correct significantly. However, he says increased demand is returning to the market from other parts of the world.
He added: “Another thing worth noting is that the discount is unusually wide at the moment,” Scott said. “It has traded at a premium in the past when people were keen on the trust but is currently trading on an 18.7 per cent discount.”
“There are very few trusts out there in the current market where the upside potential is more than double the current share price, and this is one of them.”
The Geiger Counter Trust is 1 per cent geared and its ongoing charges are 2.96 per cent.
